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To begin, you need to figure out how much money you'll need each year when you retire. In one pot, put essential expenses, such as food, housing, clothing, auto, utilities, medical and taxes. That's your floor. In the other pot, put your lifestyle expenses — hobbies, gifts, entertainment and travel.

Option 1: Safety 1

Planners have two broad ways of funding these two parts of your retirement. Some take a safety-first approach, as outlined by economist Zvi Bodie, coauthor of Risk Less and Prosper. He advises you to cover all your essential expenses with guaranteed sources of money, including Social Security, a pension, lifetime-payout annuities, I-bonds (inflation-adjusted U.S. savings bonds), short-term bond funds and certificates of deposit. If you're married, your safe investments should cover you and your spouse.

If your safe investments won't produce enough income to cover your "floor" expenses, the answer is to rethink and reduce your expenses, Bodie says. You can't afford to gamble on stocks for growth. You might lose capital or run out of money. If you hold enough safe investments to more than cover your essential bills, however, you can afford to risk some money in stocks or stock mutual funds, to cover lifestyle expenses. This part of your budget can rise or fall, depending on how the market performs.

Option 2: Total Return Investing

The second and more traditional approach — known as "total return investing" — uses the famous 4 percent rule. You own a portfolio of diversified stock and bond funds, with roughly half in stocks. At retirement, you withdraw 4 percent of your assets in the first year, and raise that amount each year by the inflation rate.

At today's low bond-interest rates, however, 4 percent is too high, says William Bernstein, a portfolio manager and author of The Ages of the Investor. A 65-year-old should probably take just 3 percent, to protect his principal, he says. Or you could start with 4 percent and skip inflation adjustments when the market is poor.

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Option 3: Mixing It Up

There's an interesting third approach, based on research by Wade Pfau, a retirement income specialist at the American College of Financial Services in Bryn Mawr, Pa. Pfau built a range of retirement portfolios from two simple investments — low-cost index mutual funds that follow Standard & Poor's 500-stock average, plus low-cost single premium annuities, which pay you (and a spouse) an income for life. He applied the 4 percent spending rule for a couple, age 65. The annuities paid more than 4 percent, so he put the extra into the stock fund.

All these portfolios — whatever the proportion of stocks to annuities — covered the couple's retirement spending in almost all situations. They also left more money at death than a traditional portfolio.

To pursue the safety-first solution, you have to be a black-belt budgeter and saver. Work as long as you can, including part-time work; put off taking Social Security (the delay increases your future monthly income); cut spending and pour savings into guaranteed investments. Consider TIPS (Treasury inflation-protected securities), but not now — wait until interest rates go up, both Bodie and Bernstein say.

A total return investor is taking a greater risk for a better lifestyle. For you, Bernstein recommends this rule: The percent of bonds in your portfolio should equal your age, with the rest in stocks. At 55, for example, you'd be 55 percent in bonds and 45 percent in stocks. You're aiming for savings worth 20 or 25 times the amount of your annual living expenses that aren't covered by Social Security or a pension. If you approach those numbers, take money out of stocks, Bernstein says. Build up your safety-first investments.

Jane Bryant Quinn is a personal finance expert and author of Making the Most of Your Money NOW. She writes regularly for the Bulletin.